The Fred Sanford Way
April 12, 2010
Good morning. Another positive week for the market last week, as the market has continued to creep up steadily since the correction low of 104.58 on February 5. Last week the SPY was up 1.25 to close at 119.55, a gain of 1.5%. Interestingly, the VIX, which has been trending steadily down as the market has advanced, had a fairly strong advance on the week, closing up 9% at 17.46. The continued upward sloping skew of VIX going up as we go out in time is still in place, with the May SPY at the money call at 14.3, September at 16.8, and December at 17.8. The market continues to price in an increase in market volatility going out, or some combination of rising volatility and interest rates, which would have the same effect. It should be noted that the correction we saw early this year began right about this time, at the beginning of the earnings cycle, and reached a bottom on Feb. 5. I am certainly not predicting that there is some calendar effect with earnings, or that anyone should adhere to the old adage “sell in May and walk away.” However, there does seem to be some stress entering the market as interest rates have begun to creep up and some of the government expansion programs, the $8,500 credit for first time home buyers and the government purchased of mortgages, come to a halt.
How do you judge the state of the economy? Clearly somewhat better that a year ago in terms of institutions that were teetering on the brink of collapse, and better in terms of monthly job loss, but no improvement at all if you were on of those laid off early. For those people there has been no significant job creation, and they are at risk of having the unemployment insurance run out totally in the next couple of months. Also, in an effort to make sure they get their money back from the high profile governmental loans to banks all supervision has been seemingly put on hold. The incredible liberties the banking industry is taking (and has been allowed to take) with the citizenry in terms of fees and interest rate spreads between deposits and loans have reached a level way beyond criminal, in my opinion. Of course, if you are Tim Geithner, all you care about is that the government is paid back on the “official” TARP loans, and that he is considered the man who “saved” the Banks. Never mind how they got the money they miraculously have been able to pay back so soon.
The states and other governmental bodies have not fared as well as the Banks, however. Unable to create money like the Federal government and not judged as “important” as the major banking institutions with the high priced lobbyists, the states seem to be sliding into the abyss. Illinois has lost 425,000 jobs in the last decade, and if you consider population growth, would need 600,000 jobs to get back to the same place. New York State has lost something like 322,000 jobs since April 2008. It is surely clear that the economy is in the calm before the second storm in regards to the landslide of increases in taxes and fees taking aim at the regular person later this year and next. In Illinois, for instance, the state is in arrears $90 billion in pension plans and $40 billion in under funded retiree health care costs, and every sort of potential increase in revenue is being discussed. Some of this was surely unanticipated in the sense that who would have thought that the investments in those funds would have done so poorly in the last decade (market virtually unchanged and very little return on cash). Combine that with high fees paid to the politically connected money managers that continue get theirs despite poor performance and you have a compounded problem. In any case, the $130 billion pension hole divided by the roughly 4.6 million households in Illinois gives you an over $28 K pension hole per household. That is a big number to pay former governmental employees, some of which worked 20 years or less for those benefits.
In case they have not figured it out, and I mean the average hack Illinois politician. The normal household, battered by the job market, enduring 10% mortgage delinquencies, most having no pension plans or seriously under performing 401ks, ready to be pummeled by tax increases at all levels, has no willingness or ability to come up with that money for those self deemed to be “entitled,” by that I mean people like you. As reserved in terms of political dissent as the average citizen here has become, I think even our typical couch spud will be concerned when he or she, maybe without a pension plan after 50 years of work, is asked to specifically pay out so a County Board member, State Representative, or even fireman, can have an absurd one after 20 or less years on the job. Time will tell and it will be interesting, hopefully not violent interesting.
What does this have to do with investing? Why the continued connection between politics and investing on our radio show and in this blog? Well, you have to be (as Fred Sanford used to say) a “dummy” to not look down the road and see the likely scenarios. Higher costs of doing business in the various states will stifle investment, as well as profits, and combined with general tax increases states like Illinois will insure the fact that they never will get back those jobs lost. Increases in taxes will also drop consumption and investment by individuals as well, and prices will increase on those products where the industries have concentrated pricing power (an increasing amount it seems). It becomes an impossible task, getting increased amounts of money out of fewer and fewer jobholders. Those are market head winds, and surely head wins for the State of Illinois ability to attract some new business. Not that it can’t happen, the market could still go up and Illinois will get some new businesses, but the retardation will be extensive in regards to what it should have been. The even bigger problem is that Illinois is like most other large states; look at the numbers in New York and California.
What about the widely cheered good numbers last week indicating, “The consumer is back.” It obviously is my analytical training (and maybe it is a good thing we are a dying breed) that has me really questioning how many months we can cheer income growth of .1%, consumer spending up .3%, credit card balances down $11.5 billion, and retail sales up 9% from last year. Those numbers are better than last year, and may be sustainable, or even right, but it sure does not seem like they match. Or maybe we have socially reached a level where many will consume without any regard for ability to do so. I do know that the Federal government is spending in excess of twice as much as they take in for many of the months in the last year, again making it very difficult to gauge what the economy and market will be like a year from now when even they will have the sense to slow down.
So far it looks like the bigger firms, with better access to the government corridors, are going to be the leaders when we exit the recession for real. A lot have pricing power, have been able to maintain their margins through layoffs and general weakness in the labor market, and have amassed large cash reserves to get even more concentrated and increase market share even more. Clearly, the judgment of our elected officials is being severely influenced by those with access, meaning that when the bills for this largess finally go out the burden will be anything but even. It would not surprise me at all that in the same week our bought and paid for government might announce some sort of foreign tax holiday for big businesses with imaginative accounting; they also announce some value added tax to take a tax bite out of some small businessman or consumer who is barely breaking even.
I am sure most of you in the SPY part of the PIP Program have noticed that we have put on some long premium positions in the near term. I have written that we have seen a very positive skew in the VIX going forward, meaning that nearer term implied volatility is relatively inexpensive. We have decided to go long that premium, essentially questioning the conventional wisdom that has the market quiet in the near term and then moving more later this year. If we were to get any near term market volatility we will be in the position to benefit, either up or down. The bad news is that we do need dome movement to do well.
Those that do some of the discretionary trades have noticed that we are also trading the interest rate ETF (TLT). I have said many times that I have an overriding bearish bias to the bonds here, meaning I think the longer term view for interest rates is up. Having said that, I do not feel it will just be an easy goes short trade. We managed to do well with the last position, getting into the 91-87 put spread when the TLT was over 91 and exiting when it was roughly 87.5. Now, however, the TLT has bounced back over 89 and we will look to re-establish the short position anywhere near 90. Like I said, I would not be surprised to see it in the low 80’s by this time next year, but with a bumpy ride. I will also be looking hard this week for any overselling of premium this week in some of the stocks or indices, I would love to catch the market napping and have some movement occur while we are long premium.